China Calls for More Government Financing in Venture Capital

China’s government is developing a bigger appetite for venture capital.

The country’s powerful State Council is encouraging more government agencies and companies to funnel money into private startups while getting the state to take part in the nation’s technology boom. In a new document published on its website Tuesday, the country’s cabinet urged government-led funds to play a greater role in guiding venture capital investment, while promising to level the playing field for foreign VCs.

Venture capital has proven crucial in driving the growth of a private sector long neglected by banks, and in creating national champions from ride-sharing leader Didi Chuxing to Alibaba Group Holding Ltd. and Tencent Holdings Ltd. In past years, the government has encouraged entrepreneurship to bolster the slowing economy, and begun playing a major, direct role in startup investment.

“With the current rate of slowdown in the economy, the Chinese government wants to have a more vibrant market and they will need more companies to mature. All that needs funding,” said Hans Tung, a general partner at GGV Capital in Menlo Park, California. “It’s best that the local government guidance funds invest into existing VCs instead of directly participating in the market.”

The government’s move deeper into venture capital comes with risks though. The impending influx of cash risks stoking a boom-and-bust cycle, similar to previous government-led efforts in solar and wind power. Public agencies may also come under pressure from officials to put money into the projects of friends or relatives, increasing the chances that taxpayers are hit with losses.

“The biggest problem with these government venture and even so-called private equity is that like most things in China, it’s not concerned about profitability and economic efficiency,” said Victor Shih, a professor at the University of California, San Diego who focuses on Chinese politics and finance. “If these funds are funded by credit, they will end in disaster because no one will have any skin in the game, which will open these funds to abuse.”

Private venture firms have already been stepping up their investments. Venture deals more than doubled last year to almost $39 billion, or about a quarter of the global total, London-based consultancy Preqin Ltd. estimates.

The amount of state capital threatens to overwhelm the private firms. Chinese government-backed venture funds tripled their money under management in a single year to 2.2 trillion yuan ($330 billion) in 2015, according to consultancy Zero2IPO Group.

The State Council in Tuesday’s document emphasized the need to prevent investment bubbles and thwart illegal fundraising, both major risks in a country where mom-and-pop investors tend to dominate stock market trading and often use their smartphones to invest more than $1 trillion in personal savings. “It’s very ambitious,” said Shih. “But down the road there might be very serious losses, and it’s government money, so tax payers will take a loss.”

The new State Council guidelines, while light on details, outlined a broad spectrum of objectives and directed agencies from the securities regulator to national economic planner to oversee specific initiatives. It expresses global aspirations, calling on local companies to develop VC funds that invest abroad. 

The cabinet urged state firms to invest in venture capital or set up their own funds, and said it will consider letting local government financing vehicles, which borrow on behalf of local governments, to become venture capital firms. It wants to improve the environment for VC exits by establishing startup-friendly stock market boards. And it promised to level the playing field by easing entry for foreign VC firms.

“Venture capital is an important method of improving investment structures and increasing effective investment,” the State Council said. One aim should be to “promote China’s venture capital industry to among the world’s most advanced.”

— With assistance by Lulu Chen